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Department of Labor, Information and Education SeT-vice, 
■ Division of Public Works and Construction Development. 

THE NEW PRICE REVOLUTION. 

By Irving Fisiiek, 

Professor of Political Economy, Yale Vniversitu. 

[Read before Conftrence of Governors aud :Mayors at the Wbite House 
March 3-5, 1019.] 



STALLED BITSINERS. 

At the present time there is a marked halt In production. In- 
dustry is slowing down. Unemployment of labor Increases. 
Some industrial concerns are falling to cam profits, and others 
are suffering tlie dissipation of their accrued profits, because, 
even by shutting tlieir plants down, they can not save certain of 
their expenses or any of their fixed charges. The Government's 
revenues, dependent as they are upon the national income, may 
fall short at the vei-y time we need them most. In brief, we are 
tlireatened with a widespread business depression and from 
peculiar causes, for the unsound conditions usually preceding 
a widespread business depression are absent. 

BELIEF THAT PKICES MUST DROP. 

The main reason why business is not going ahead better is 
that most people expect prices to drop. The merchant is selling, 
but not buying. The manufacturer holds up the purcluise of his 
raw materials. People quote the disparity between present prices 
and those prevailing "before the war," and decide they will not 
buy much until present iirices get down to " normal." This gen- 
eral conviction that prices are sure to drop is putting a bralie upon 
the entire machinery of production and distribution. Readjust- 
ment waits because we keep on waiting for it. We have waited 
in vain for over three months. It is interesting to observe that 
many mauvifacturers think that prices nuist come down, in- 
cluding the price of labor; but they are ready to demonstrate 
to yon that their own prices can not come down, nor can they pay 
lower wages. Almost everyUiing they buy somehow costs twice 
as much as before thf war, and their labor is twice as dear. 
They can not pay their labor less if labor is to meet the increased 
cost of living. Now, as a matter of fact, when we investigate 
almost any individual one of the so-called high prices for indus- 
trial products we are likely to find that individually it is not 
high ; that is. It is not high relatively to the rest. Our quarrel 
is with the general level of prices. 
110458°— 19 



THE GENERAL PRICE LEVEL. 

Variations in the general price level may be compared to the 
tides of the sea, while individual prices may be compared to 
waves. Individual prices may vary from this general level of 
prices for specific reasons peculiar to individual industries, just 
as the height and depth of waves vary from the general level 
established by the tide. The causes controlling the general 
price level are as distinct from those controlling individual 
prices as the causes controlling the tides are distinct from those 
controlling individual waves. 

INDIVIDUAL ■\T5E.SUS TJNIVEESAL PRICE INFLUENCES. 

AJl prices have risen, but some have risen more, some less, 
than the average for particular reasons affecting each industry. 
In some cases an impro\'ed organization of both employers and 
employees has enabled them to combine against the public and 
take full advantage of the price advance. The war brought 
about an abnormal demand for certain products like copper and 
steel, and they advanced faster than the average. The abnormal 
demand having disappeared, these prices are being adju.sted 
downward. Wheat is a case where demand increased and at 
the same time certain of the usual sources of supply — Russia, 
Australia, and Argentina — disappeared, with a resultant abnor- 
mal price increase. The closed sources of supply have opened 
again, and wheat prices in the world market have dropped. 
Ill some cases, as in many of the industries making building 
materials, the war meant a gTeat slackening in demnnd, an 
enforced curtailment in use by Government order. In such in- 
stances we are likely to see an upward swing in prices as the 
suppressed demnnd again makes itself felt. To-day we are wit- 
neksing throughout the country such price read.lustments, up 
and down, but the general price livel has shown little sign of 
falling, as is evidenced by price index numbers. It is apparent 
to every thoughtful observer that some great force has aifected 
all prices, creating a new standard to which they are all con- 
forming. 

The fundamental practical question confronting busine.ss men 
is whether the general level of prices is going to fall. In my 
opinion, it is not going to fall much, if at all. We are on a per- 
manently higher price level, and the sooner the business men 
of the country take this view and adjust themselves to it the 
sooner will they save themselves and the Nation from the mis- 
fortune which will come if we persist in our present false hope. 

ITS DEPENDENCE UPON THE CIP.CUXATING MEDIUM. 

The general level of prices is dependent upon the volume and 
rapidity of turnover of the circulating medium in relation to 
the business to be transacted thereby. If the number of dollars 
circulated by cash and by check doubles while the number of 
goods and services exchanged thereby remains constant, prices 
will about double. 

The great price changes in history have come about in just 
this manner. The " price revolution" of the sixteenth century 

t5: •^ j*» 

APR W I9t9 






^ 3 

^- came upon Europe as a result of the great influx of gold and 
silver from the mines of the New World. Europe was flooded 
with new money. More counters were used than before in ef- 
fecting exchanges and prices became "high." People talked 
then of temporary " inflation," just as they talk of it now. But 
it was not temporary ; it was a new price level, 

A similar increase in prices all over the world occurred be- 
tween 1S9G and 1914, following the discovery of the rich gold 
fields of South Africa, Cripple Creek, and Alaska, the invention 
of the cyanide process in mining, and the vast extension of the 
use of bank credit 

EXTENSION OF CREBITS. j 

Circulating credit — that is, bank deposits subject to check 
nnd bank notes — is a multiple of the banking reserve behind 
these deposits and notes ; and the essence of this reserve is gold. 
Our present jnonetary system is an inverted pyramid, gold being 
the small base and bank notes and deposits being the largo super- 
Rti-ucture. The superstructure grows even faster than the base. 
The deposits are the important elements. They are transferred 
by check from one individual to another; tliat is, the circula- 

. tion of checks is really tlie circulation of deposits. 

Thus any increase in the country's gold supply has a multi- 
plied effect. The possible extent of that effect is dependent 
upon (1) the amount of gold available, and (2) the gold reserve 
requirements, determining the volume of credit that can be put 
into circulation based upon the gold. Over a billion dollars in 
gold has come into this country from abroad since 1914, and a 
large amomit has disappeared from domestic circulation. The 
gold from both these sources has found its way into the United 
States Treasury and into bank reserves. On June 80, 1918, the 
portion of the gold reserve of the Federal reserve banking 'sys- 
tem which supported national bank deposits and Federal re- 
serve notes was more than three times as large as the gold 
reserves under the old national banking svstem on June 30 
1914— $1,786,000,000, compared to Jii592,0OO,006. During the same 

-T)eriod credit Instruments (demand deposits and notes) increased 
about twofold— from $0,100,000,000 to $11,700,000,000. This in- 
crease of credit instruments is tyr)ical of the banking situation 
for the country as a whole and largely explains the present high 
level of prices. The increase of gold has been so great how- 
ever, that the base has grown faster than the superstructure— 
which is contrary to the normal tendency. The ratio of gold to 
credit has risen from 9.G per cent to 15.3 per cent. The le^al 
reserve requirements of the present system are such that for 
1918 there is an excess of gold above these requirements of more 
than $700,000,000. The reserve required by law to support the 
$11,700,000,000 of credit instruments of 1918 is $1,070,000,000. 
The $700,000,000 of free gold could support an additional super- 
structure 70 per cent as large as tlie existing one, which indi- 
cates that for the banking of the country as a whole a potential 
luture expansion of 50 per cent is a conservative estimate. 

FALSE VIEWS OF INFLATION. 

Afany people, referring to this inflation in the circulating 
medium, and assuming tliat it is temporary, are waiting for this 



inflation to subside. Wlien we speali of inflation we mean more 
circulating medium than is needed to transact the business of 
ttie country on a given price level. But what price level ? Some 
people mean the price level of 1913-14. Our currency is cer- 
tainly inflated in terms of the prices of that period, just as the 
currency in 1914 was inflated v,'ith respect to the prices of 1896, 
but our currency is not inflated at the present time relative to 
the new level of prices in the world which the war has brought. 
The countr3^'s volume of money will have to be judged in terms 
of tills new price level, not in terms of a price level that is past. 
To speak of the present " inflation " as temporally is to assume 
the very thing about which we are contending — to assume that 
the normal prices are those of 1914. 

BASIS OF EXPECTATION AS TO FUTURE MOVEMENT OF PKXCES. 

Let US examine the factors upon y^hich any future price move- 
ments must depend. • 

1. Gold loill not return to circulation. — No great effect in the 
direction of falling prices can be expected from any return of 
gold and other lawful money into daily circulation. Such a 
reversion would be contrary to monetary experience everywhere. 
When people have learned to leave their gold and silver in the 
banks and use paper money and checks instead they find the 
additional convenience so great that they will never fully return 
to the old practice. 

2. No great outflow of gold through international trade. — It 
should be noted that many of the former reasons for a flow of 
gold from America abroad have disappeared. We used to owe 
Europe a huge balance of interest payments upon American 
securities she held. The situation is reversed to-day. Moreover, 
Europe must pay us money for the materials we will send her 
for reconstruction, or at least pay us interest on credit we will 
extend her. Thus our exports will probably exceed our imports 
durmg the reconstruction period. We used to pay oce.-in freight 
money to foreign carriers ; to-day the American merchant marine 
will keep in American hands tens of millions of dollars of ocean 
freight money. The huge volume of American tourist travel 
abroad, for v/hose expense we had to settle, has stopped and can 
not resume for a year at least. For all these reasons the lines 
are laid for a movement of gold from Europe here rather than 
a movement of gold from America to Europe. 

" Yes, but," people say, " wait until trade is re.<?umed between 
the United States and Europe, then surely ' low-priced European 
goods ' will flow over here in such enormous volume that they 
will liquidate all annual obligations to us in goods." Ultimately 
Europe must pay her obligations to us in goods, but it vnll take 
many years. Meanwhile she needs our tools, machinery, and 
raw matei-ials for immediate reconstruction. 

THE FACT : EUROPEAN PRICES HAVE RISEN MORE THAN OURS. 

At the present time European goods are not " low priced " 
(however little the money wages of European labor will buy). 
Prices in Europe since the war began have risen more than they 
have in the United States. The price rise has been less the 



farther from the seat of hostilities. It was least in Australia 
and New Zealand. It was next least in the United States, Can- 
ada, and Japan. Then came neutral Europe; then our present 
allies: and finally Germany and Russia. Gold tends usually to 
flow from high-priced countries to low-priced countries, so that 
until " inflated " European prices fall gold is not likely to flow 
thither. Prices are no more likely to fall there than here, and 
for the same reasons, which will be explained below. 

3. Reduction of ontstanduiff credit. — The chief dependence of 
those who predict Iov,er prices is on a reduction oi' the super- 
structure of credit resting upon our gold rather than on any 
reduction in the volume of this gold itself. They look for a con- 
traction of bank credit, a reduction in the volume of deposits 
subject to check, which circulate throughout the country. 

EFFECT or GOVERNMENT LOANS ON CREDITS AND I'RICES. 

But the main cause for the present extension of bank credit 
is the liberty loan, and there is soon to be another. SuI)scribors 
for the new loan will not pay for their bonds in full any more 
than they did in the previous cases but rather less. Many oL" 
them will deposit the bonds with the banks as security for loann 
to be repnid later. The effect on our circulating medium will 
be the .s.-ime as if the Government were to impose a levy of 
$6,000,(300.000 of ci-edits upon the Federal reserve banks, and 
then order them to apportion these credits out amon,'; the banks 
of tlie country. Tins process will certainly lead to an expansion 
of credits. The former issues of liberty bonds are stiil carried 
by the banks to a considerable extent. It may be contended 
that the bank credit expansion represented by the new victory 
notes has ali'eady occurred in the form of Treasury certificates, 
which are merely to be funded by the victory notes. The victory 
note issued thus represents only a shifting of the obligation to 
pay credits advanced to the Government, a shifting from the 
shoulders of the banks to the shoulders of the victory note 
buyers. The volume of outstanding bank credit remains rhe 
same. To a certain degree this contention is true. But a portion 
of the April victory note issue will go to pay future expenditures, 
not accrued expenditures. Then as soorr as the Government 
needs additional money, it will issue new Treasury certificates, 
resulting in new extension of bank credit. Moreover, there is 
little doubt that there will be at least one more Government 
bond issue during the reconstruction period, and this will tend 
to further increase our present credit structure, 

FOREIGN GOVERNMENT BORROWINGS, SAME EFFECT. 

The banks must lend credit and create deposits to meet the 
expenditures not only of our own Government, but of foreign 
Governments as well. The same thing results even if these 
Governments are served directly by private investors here in- 
stead of via the United States Treasury. These investors pay 
for foreign Government bonds as they do for our liberty bonds — 
on the installment plan — paying a small part down and boi-row- 
ing the rest from the bank. This increased purchasing power 
will be mostly spent in this country for supplies to be sent abroad 



for rehabilitation. Tliis continuance of A'ast loan issues, con- 
nected with war and reconstx'uction throughout the world is a 
factor which will maintain the high price level temporarily, 
>\'hich means many months. 

It is also worth keeping in mind that liberty bonds and other 
Government securities held here do not wholly cease being a 
source of credit expansion when the individual subscribers have 
completed their payments on tlie bonds and really own them. 
These new bonds are unrivaled security for further borrowings 
from banks for commercial purposes, and they will continue to 
be so until the Government which issues them redeems them. 

The availability of the vast issues of war bonds as bases for 
future credit expansion, coupled with the fact that our banking 
system has still many unused reefs, sure to be taken out later, 
when business wishes to spread more sail, is the chief reason 
why prices will keep up permanently ; that is, for many years. 

Between the period of temporary and the period of permanent 
effects, there may be a slight dip in the price level, say a year 
from now. If so, it is the more incumbent upon business to 
proceed now; for it can not wait a year. 

COMMERCIAL LOANS MUST INCEEASB. 

During the war the flotation of stocks and bonds of commercial 
concerns has been vei-y greatly diminished. During tlie period 
upon which we are now entering, the issue of such securities 
will increase greatly. 

OPPOSITIOIS! OF BUSINESS MEN TO CKEDIT CONTBACTION. 

Against any considerable reduction in bank credit and hence 
In the general level of prices, we shall find the whole business 
community in arms. Falling prices mean hard times for the 
individual and for the Nation and every one resists the tendency. 
At the end of tlie Civil War the Treasury started to reduce the 
quantity of greenbacks. A start had hardly been made, how- 
ever, before the business depression of 1866 and 1867 caused 
Congress to forbid by law any further reduction. Should the 
Federal reserve banks attempt, by raising their discount rate 
or otherwise, to reduce the volume of bank ci-edit outstanding, 
they will meet with the same sort of oi^position. Moreover, the 
hostile attitude of labor toward the lowering of wages will 
deter legislators and bankers from any organized policy of con- 
traction. ' ^ "^ ^ 

INCREASE IN DEPOSIT BANKING ON THE CONTINENT. 

Looking into the still more remote future, there will be in 
Europe, particularly on the Continent, a vast increase in deposit 
banking. The need of the Governments there for funds during 
war times hastened the introduction of deposit banking. Money 
went out of circulation into bank vaults, and tliere became the 
basis for circulating credits. This means a new habit which 
will lead to a great currency exiiansion. Far-away countries, 
like India and China, are also learning to use deposit banking. 
It is as if a new source of gold supply had been discovered. 
What has been discovered in a new way of using the gold supply. 



The world, during the course of the war. has thus started, or has 
hastened, an equivalent of the price revolution of the sixteenth 
century. 

GO AHEAD ON THK NEW PRICE LEVEL, 

Business men should face the facts. To talk reverently of 
1913-14 prices is to speak a dead language to-day. The buyers 
of the country, since the armistice, have made an unexampled at- 
tack upon prices through their waiting attitude, and yet price 
recessions have been insignificant. The reason Is that we are 
on a new high-price level, which will be found a stubborn reality. 
Business men are going to find out that the clever man is not 
the man who waits, but the one who finds out the new price facta 
and acts accordingly. 



WASHINGTON : GOVERNMENT PIUNTING OFFICE : ISlt 



LIBRftRY OF CONGRESS 



013 715 246 4 



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HoUinj 



LIBRARY OF CONGRESS 




013 715 246 



HoUinger Corp. 
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